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Do You Need to Be Smarter Than A 5th Grader to Flip Houses?

by Michael LaCava on November 3, 2012 · 28 comments

  
house flipping with 5th grade math

When you’re first learning how to flip houses, most grizzled real estate veterans will tell you how important it is for you to know “the numbers”.

One things for sure, if you don’t know your numbers…your house flipping career will be short…and excruciatingly painful.

The cool thing is that in the flipping houses niche, you don’t have to understand complex mathematical formulas, have a PhD in astrophysics or possess the intelligence level to unravel the human genome.

Thank God because I can’t do any of those things

All you need to know is just a little fifth-grade math…as well as have a whole lot of desire.

Fifth-Grade Math and the 70% Rule

When it comes to the math component of most house flips, there are some common rules and formulas that you really should understand inside and out before you get into this business.

And best of all, any fifth grader can do it…

For example, here is a complex mathematical formula to test you on:

200 x 0.7 = y

y = ?

Have I lost you yet?

If you answered 140, then congratulations! You have the necessary math skills to be a house flipping superstar.

In doing the extremely complicated mathematical formula above, without even knowing it you have tapped into one of the most important house flipping formula of all.

If you stick to this formula, I guarantee you it will save you thousands and dollars in mistakes in your house flipping career…

And it will make you a ton of money as well.

The Most Important Formula When Flipping Houses

The math we did above was what we refer to as “The 70% Rule”.

Where it came from…I have no idea. But all I know is that IT WORKS.

Although it can’t be exactly applied in every single market, its extremely important to stick by this rule when you are doing your house flipping math.

So as soon as you determine your ARV, (the after repair value of a home or property), the very next step is to use the 70 percent rule to figure out what you need to buy a property for in order to turn a profit.

The accuracy of the 70% rule also depends on your level of experience in gauging the after repair value of a house. This is largely dependent on getting an accurate after repair value to begin with. This number is what you have gotten from your real estate agent or other people on your house flipping team.

As with most things in life, the more experience you have flipping houses and using the rule, the more accurate your estimates will become.

So let’s do an example…

The 70% Rule In Action

You’ve been looking long and hard for your first house flip deal, and you finally come upon a house that according to your real estate agent, if it were fixed up comparable to the neighborhood, would sell for $200,000.

On top of that, there are several comps in the area in the past six months that give you confidence that $200,000 is a fair and reasonable price.

This is where we start our fifth grade math.

1. Take the $200,000 and multiply it by 70% (or by 0.7 on your calculator, for you math whizzes like me):

ARV=$200,000

70% rule: $200,000 x .70 = $140,000

2. Take your $140,000 and now deduct your repair costs. In this case, let’s say that your rehab expenses are $40,000 according to your contractor. Then subtract the $40,000 from the $140,000. This will then give you the maximum price you should pay for the property:

Repair costs = $40,000

70% rule = $140,000

$140,000 – $40,000 = $100,000

Maximum purchase price = $100,000

Pretty simple stuff.

The question is, can you actually get the house $100,000?

That may be a blog post for another day, but let’s say that you can.

So you take the plunge and buy it!

Why the 70% Rule Is So Important

In its simplest form, the 70% rule helps to insure you against taking unnecessary risks and keeping your house flip buying very disciplined.

Even the worst-case scenario, the 70% rule will help to ensure that you do turn a profit or at the least break even.

As simple as it may be, when you’re first learning how to flip real estate, this is a rule you should stick by to keep yourself out of trouble as well as lock in maximum profits.

It also keeps you from fudging your numbers (or “eraser math” as we call it) in order to get the deal done.

The seventy percent rule can save you a lot of dough and prevent you from creating a bad deal….but only if you stick to it on each and every deal.

House Flipping in Expensive Markets: Exceptions to the 70% Rule

As with all rules, there are always exceptions. And as each real estate market is different, the 70% rule needs to be adjusted depending on your market conditions.

I often times use $200,000 as my benchmark for after repair value because that’s what is typical in my market.

I happened to flip lower price ranged starter homes and I found this market to be very lucrative.

We’ll occasionally flip houses in higher price ranges (and are doing more of those now as a matter fact).

But for the most part, I stick to what I really know in the mid-range to lower-priced mark it is where I feel most comfortable right had the most success.

But your market might be different.

If that’s the case, then you may need to adjust the 70% rule to suit your needs.

As a general rule, here are the exceptions to the 70% rule:

  • Higher-priced markets: The higher the price a property, the more flexibility you have on the upside for the 70% rule. In these cases over $200,000 ARV, you may consider to be “higher-priced”. In these cases, you may want to go to 80% or even 90%.
  • Lower-priced markets: The lower the price of a property, the more flexibility you have on the downside for the 70% rule. In these cases, any house flip under $200,000 ARV you may want to consider to be “lower-priced”. In these cases, you may want to go to 55 or even 60%.

Whatever your market, the most important thing is that you adhere to the rule as best as you can. This may result in you turning down some deals. If you’re first starting out, this is actually a good thing.

I can tell you this though…this one simple rule has kept me out of more bad deals that I can even care to remember!

What do you think? If you made it this far, please leave me a comment below! I’d love to hear about what you think of “The 70% Rule” or questions about anything at all relating to real estate!

Photo: Bart Everson

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{ 28 comments… read them below or add one }

Robert Watkins November 3, 2012 at 10:56 am

Hello Mike,

I agree this is the simplest way to have a bases for a flip.

Thankyou for your post.

Robert

Reply

Michael November 3, 2012 at 6:00 pm

Hey Robert,
When you do a lot of flips – deals are hard to come by sometimes and you can certainly get tempted.The same holds true if you are first starting out and you want a deal real bad so you find a way to justify arriving at the 70%. I can speak from experience but in the end the math is simple. It’s us that can over complicate it.

Thank your for your comment.

Reply

Michael Borger November 3, 2012 at 1:17 pm

Good recap post. I find that another formula can also work well: 90% of ARV — repairs costs — whatever profit you want to make. That way you’re taking 10% off the top for your holding, transactional and lending costs and backing out your renovation costs to arrive at your break-even number, i.e doing it for free. Then just account for however much profit you think is fair and that’s your maximum offer.

Reply

Michael November 3, 2012 at 6:05 pm

Hi Michael,
That is a great point & a perfectly fine way to do it as well. Do you adjust what you want to make according to your all in costs. For example if you had an ARV at $200,000 and then another at
$500,000 what you would you add on for your projected profit.

Thanks for sharing your strategy.

Reply

Michael Borger November 3, 2012 at 9:49 pm

Yes, the projected profit should generally reflect the amount of resources put into it. Also, the higher the price point the wider the general range of the final selling price, so again, a higher minimum profit would reflect the higher safety margin required. For an ARV of $500K I would probably seek a minimum profit of $50K. Maybe $30K on an ARV of $200K (but in Hawaii that price point is condos only!). :)

Reply

mike November 4, 2012 at 6:55 am

How is the Hawaiian market. Many Reo’s?
I beleive you have the one of highest per sf cost on home prices there.
I want to visit paradise some day.

Fay March 21, 2014 at 10:45 am

Thank you so much for the information! I am from Hawaii and, although I have been investing in real estate for the past 15 years, I have recently decided to started flipping properties! The 70% rule would be a little difficult here, and you’re correct, the $200K ARV would be for condos only… I believe the median condo range is in the mid $300K’s right now. Sometimes you can get lucky and find the “diamond in the rough” though. Aloha!

Michael March 22, 2014 at 10:34 am

Hi Fay. Every market is different and will determine whether or not you can buy at 70% or better or higher. Once you can’t buy at a level you feel is comfortable or doesn’t make sense financially then you either have to move on or take on more risk or less profit. I only suggest buying at 80% max and for more advanced investors because most newbies will go over on their renovation projections for sure. Even advanced investors go over including myself but at the 70% rule it doesn’t hurt too much but at 80% and higher it sure can matter on your bottom line.
I have’t been to Hawaii but want to visit some day for sure

Terry November 3, 2012 at 1:53 pm

Good post. If you take it up just one notch and have a $300k ARV and $50K in repairs, what percent would you recommend? Still 70 or maybe 75?

Reply

Michael November 3, 2012 at 6:09 pm

Great question Terry!
I would always try for the 70% or better but it depends on your market and competition. If you think you need to go to 75% to get the deal because competition is fierce then you just might have to do that. Just make sure you are soldi with your ARV projections and repair costs.

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Chris Clothier November 3, 2012 at 2:04 pm

Mike –

Nice detail! I know how hard it is to write sometimes, but I think this is a really good article with lots of good and very pertinent information. You used a word in the middle of your article that is so important for every real estate investor to remember: DISCIPLINE. Many of us who have been around for some time can probably give plenty of anecdotal evidence about what happens when you are not disciplined.

Great stuff – Chris

Reply

Michael November 3, 2012 at 6:13 pm

Hey Chris,

You are so right. The good thing is as long as you learn from the deals you used eraser math on to justify the purchase price or overlooked the boat sinking in the neighbor’s front yard then it gets better. I love helping others because I can tell them what to avoid from experience and as you know that is just important as what to do!

Thanks for your comments!

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Karen Rittenhouse November 4, 2012 at 7:10 am

Mike – Very well laid out information.

I have students tell me all the reasons those numbers don’t work for the seller and then they want permission to adjust the numbers (for the seller’s benefit?).

As buyers, we must figure OUR numbers. What works for US, and stick to it. The numbers don’t lie and, as you said, if you can’t do simple math, your house flipping career will be short.

Thanks for the post.

Reply

mike November 4, 2012 at 7:18 am

Thanks Karen.
So true. I feel just as happy if not more when I talk new investors from getting out of a flip vs getting into a flip.
Thanks for your comments

Reply

clemente dominguez November 5, 2012 at 5:24 am

I have been rehabbing houses for investors for over three years and I am looking for houses in Tampa to begin my own flips.I thankyou for your tip on the 70% rule,it is really helpful.

I was wondering if you know of any hard money lenders or private lenders in my area,I would appreciate it very much.

Thanks again,and I look forward to more of your blogs.

Warm regars,
Clemente

Reply

Michael November 5, 2012 at 1:53 pm

Hey Clemente. I haven’t done anything in your area but I will check with some of my lenders and see if they work or know other lender’s in your area. Email me directly & I will follow up with you.

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Frank November 14, 2012 at 7:27 pm

Love the 70% rule. We use it. It works. We love simple calculators! Great post.

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Michael November 15, 2012 at 6:35 am

Thanks much Frank. It works no doubt. Factor in 20% for your margin and 10% for your soft costs like finance, commissions, attorneys and get your projections right and it’s a winning formula, no doubt. What kind of properties do you use it on?

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gretchen December 12, 2012 at 10:53 am

Thank you so much – I have been using a more complicated formula for myself, but looking at the numbers they are almost all right one the 70% rule. This will be much quicker for me to seal the deal, I can take anything times 7 in my head!

Reply

Michael December 12, 2012 at 1:47 pm

thanks Gretchen – It really is a great way to do what I call 5th grade math to come to a very quick decision if the potential deal needs to be looked at in more detail.
Please share you math – I always like to here how other’s are doing it.

Thanks for your comments on BP

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Jordan January 23, 2013 at 2:13 pm

This 70% rule is very helpful. Thanks! Question though: when you subtract your repair costs, are you including the fixed/holding costs in that number?

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Michael January 23, 2013 at 3:17 pm

Yes the carrying costs are part of the 30% from acquisition. You can certainly try to deduct additional if you can but you also want to get the property so be smart on your offer.

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Franddy April 15, 2013 at 2:10 am

Hi Michael,
Great article as always! Could you or anyone in the blog, breakdown the 70% rule? I understand it is to cover the holding costs of the project but I mean percentage wise. Thanks in advance!

Reply

Michael April 15, 2013 at 6:52 am

Hi Franddy-

70% x ARV – repairs = MAO

example – ARV house at $200,000 x 70% = 140,000 – $30,000 (repairs) = $110,000 MAO
the 30% spread is profit minus soft costs. Softs costs can range 8%- 15% so know what they are.
If they are 10% then that leaves you a 20% profit based on ARV = $40,000

Hope that helps!

Reply

Victoria May 29, 2013 at 6:03 pm

Michael, I didn’t realize I’ve been doing the basic 70% for years. Plus research into the demographics and area comps. I’ve found curb appeal is my first cost, sign goes up and I work on a deadline both financial and time(=$) . A 10k ” didnt see that coming” is my safety net, and working with realestate agents that learn you and visa versa mean the world and % off their sale!! Thanks for sharing this with the world!

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Michael May 30, 2013 at 7:10 pm

Thanks Victoria for reading and enjoying the information. If you have any questions don’t hesitate to ask.

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James Bischoff August 18, 2013 at 2:38 pm

This is just what I needed to figure correctly, Id like to see some thing on how to find good buyers, Iam sure there is plenty more to see and learn, thanks, Jim

Reply

brian February 17, 2014 at 10:52 pm

What would you suggest for the percentage for my market between $350k to $550k ARV in cheaper parts of Los Angeles?

Reply

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